The Dark Side of the Lending Spree

By+Zhou+Xiaoyan

In China， there are many cash-hungry small and micro businesses whose needs for financial services are often ignored by big banks. On the flip side， the country， whose people have a tradition of saving， is also full of savvy investors who are in dire need of an outlet for their spare cash.

The peer-to-peer lending industry， also known as P2P， seizes this business opportunity by absorbing idle money from individuals and then providing funds to creditors that are desperate for cash. Hence， it has become a thriving and quite lucrative sector in recent years.

P2P lending is the practice of lending money to unrelated individuals and small businesses without going through a bank. This lending takes place on P2P websites. It has an average yearly interest rate of 15 to 20 percent， four to six times the returns on bank deposits in China.

In most cases， such loans are of an unsecured personal nature， and borrowers do not provide collateral against default. But now， in order to lure investors， some P2P websites in China have begun to offer principal and interest guarantees to investors， using profits accrued from the websites or services of cooperative guarantee companies.

By matching creditworthy borrowers and canny investors， the P2P lending industry is flourishing in China. However， frequent occurrence of P2P website bankruptcy or disappearance has alerted investors to the enormous fraud or default risks accompanying the promised high returns and highlighted the need for tougher regulation.

P2P lending was introduced to China in 2006. Due to a poor-performing stock market since 2008 and low bank deposit rates， Chinese investors were quick to turn to P2P sites in the quest for higher investment returns.

P2P operations became red-hot in Chinas Internet finance sector in 2013， with the number of new companies surging and transaction values skyrocketing.

By the end of 2013， the number of P2P lending companies in China had exceeded 800 with a yearly turnover of 100 billion yuan （$16 billion）， according to Wangdaizhijia （literally，“home of online lending”）， a Web portal that tracks the industry.

The China Financial Stability Report， released by the Peoples Bank of China， the central bank， has made a more conservative estimation， saying there were more than 350 active P2P online lending platforms at the end of last year， with an accumulative turnover of 60 billion yuan （$9.6 billion）.

Risky elementsendprint

As tempting as its high-return promise sounds， the P2P lending industry is plagued by many risks， including excessive exposure to high-risk industries， poor investment portfolio management， misleading and deceptive promotion， illegal lending and the absence of a sound credit-rating system. Investors find it difficult to tell which platform is rule-abiding and promises of guaranteed repayment are often a sham.

In April， a P2P lending platform named Wangwangdai simply disappeared with a huge amount of money raised from indi- vidual investors.

Wangwangdai is not an isolated case. There are dozens of P2P lending platforms allegedly involved in illegal activities， which are being investigated.

According to Wangdaizhijia， a total of 58 P2P platforms went bankrupt in the fourth quarter of 2013. In the first half of 2014， another 47 P2P websites disappeared with money raised， were found to have committed fraud or had difficulty repaying investors.

In China， P2P lenders arent classified as financial institutions， and there arent any specific rules governing the sector， so these lenders function beyond the scope of regulators.

This absence of regulation has led to risky practices by P2P lenders， such as investing with clients funds and failing to conduct due diligence on borrowers. When projects fail， lenders fail to get repaid.

In addition， the wild expansion and escalating competition in the industry have pushed up interest rates. Some P2P firms even promised annual returns of over 40 percent to woo investors， thus increasing default risks.

“Many P2P online platforms are just a transformation of former players in the private lending market， who lack a thorough understanding of liquidity management，” said Xu Hongwei， a senior executive at Wangdaizhijia. He estimated that 80 or 90 percent of Chinas P2P companies might sink.

“No threshold， no industry standard and no regulation—these factors have contributed to the wild growth of the P2P industry，” said Huang Zhen， a professor of law at Beijing-based Central University of Finance and Economics.

Systemic risks are building up due to the absence of regulators and the industrys frenetic need for growth to offset the risks， according to Bai Chengyu， Secretary General of the China Association of Microfinance.

How to regulate？

China generally encourages the development of P2P lending as its a new type of financial product innovation that can prop up reform on the countrys financial sector. But this is not to say Internet finance should be free from scrutiny.endprint

The role of a P2P platform must be confined to just an intermediary， according to finance experts. These platforms are supposed to live by brokering agreement between borrowers and lenders， and are prohibited from pooling investors money to fund their own projects. Otherwise， it would be illegal fundraising， a crime that can lead to years， or even life， in prison in China.

To deal with these problems， the China Banking Regulatory Commission （CBRC） said that it would lead a campaign to regulate P2P lending. In May， the CBRC summoned leaders of P2P websites to discuss on the market entrance threshold and regulation rules. An anonymous industry insider told China Business News that detailed regulations for the industry would come out at the end of this year.

The Peoples Bank of China has also indicated plans to introduce third-party custodians into the P2P lending industry to keep brokers from taking clients money.

Yang Dong， Deputy Dean of the Law School at Beijing-based Renmin University of China， said that supervision over P2P websites should be focused on protecting investors. He suggests differentiated supervision should be adopted according to the type of P2P websites and their capital pools.

Xie Ping， Deputy General Manager of China Investment Corp.， said that the key to supervision over the P2P lending industry lies in close scrutiny of information， necessitating the disclosure of data regarding shareholders， transactions and mangers.

“They should back up every transaction in case of future lawsuits or penalties from the government after the fact，” Xie said.

“The current supervision framework by the government is designed for banks， securities companies and insurers. They dont apply to P2P lending platforms. I think P2P supervision should be considered on the basis of information， big data and full disclosure of information，”Xie added.

Zhao Xijun， a professor of finance at Renmin University of China， suggests the government set qualification criteria for P2P lenders as with micro-loan companies and pawnshops. “The government can place requirements on registered capital， personnel qualifications and credit records，” Zhao said. “It can also ask all P2P lending firms to register and report their data regularly. Licensing P2P firms is also an option.”

Zhang Chenghui， Director of the Research Institute of Finance under the Development Research Center of the State Council， said that effective supervision over P2P lending should factor in six aspects.

“First， P2P platforms are intermediaries， so their risk control measures should be different from those designed for banks. Second， preventing fraud and protecting investors should be the core principle. Third， money laundering and illegal use of capital pool should be strictly prohibited. Fourth， there should be a national industry standard regarding P2P companiesdaily operations， and transparency is key. Fifth， self-discipline within the industry should be strengthened. Finally， third-party evaluation should be introduced，” Zhang elaborated.

“Supervising the P2P lending industry is a systematic project. The CBRC itself cant do the entire job. It also requires concerted efforts from industry associations， third-party custodians and P2P websites，” Zhang said.endprint